Efficient Market Theory
The Efficient Market Theory claims that the market is perfectly efficient, and as such is impossible to outperform. This is achieved by all relevant information (and their implications) being present in the stock price. In other words, the market acts as a Markov Chain -- the probability of the stock achieving a certain price is only dependent on its current price. The implications of this theory is that the market is completely unpredictable, and that there is a 50/50 chance that individual stocks, as well as the market itself, will go up or down.
Technical Analysis
Technical analysis and momentum trading almost contradict the Efficient Market Theory. The main idea of these two investment strategies is that given a stock's historical price and volume data statistics, we can (with a certain probability), predict the stock's future direction. Momentum trading is a subset of technical analysis, where if a stock's historical data has followed a certain pattern over a time interval, then the stock will exhibit the same behavior for a time interval in the future.
The debate between these two theories is ongoing and shifts often. The reason for this is that the opinion of the majority actually has an influence on the truthfulness of the statement. For example, the EFT essentially says that there are no inefficiencies in the market that can be exploited for a profit. However, this may not have always been true. If, for example, there were pricing inefficiencies in the market but many trading firms were able to recognize them using machine learning techniques, then by the methods of supply and demand of shares, the price would converge to an equilibrium where there are no longer inefficiencies. Because of this, while our conclusion may be true for this point in time, there may be a period of time in the future where it is no longer true, and that is what makes these two theories so interesting.
The Efficient Market Theory claims that the market is perfectly efficient, and as such is impossible to outperform. This is achieved by all relevant information (and their implications) being present in the stock price. In other words, the market acts as a Markov Chain -- the probability of the stock achieving a certain price is only dependent on its current price. The implications of this theory is that the market is completely unpredictable, and that there is a 50/50 chance that individual stocks, as well as the market itself, will go up or down.
Technical Analysis
Technical analysis and momentum trading almost contradict the Efficient Market Theory. The main idea of these two investment strategies is that given a stock's historical price and volume data statistics, we can (with a certain probability), predict the stock's future direction. Momentum trading is a subset of technical analysis, where if a stock's historical data has followed a certain pattern over a time interval, then the stock will exhibit the same behavior for a time interval in the future.
The debate between these two theories is ongoing and shifts often. The reason for this is that the opinion of the majority actually has an influence on the truthfulness of the statement. For example, the EFT essentially says that there are no inefficiencies in the market that can be exploited for a profit. However, this may not have always been true. If, for example, there were pricing inefficiencies in the market but many trading firms were able to recognize them using machine learning techniques, then by the methods of supply and demand of shares, the price would converge to an equilibrium where there are no longer inefficiencies. Because of this, while our conclusion may be true for this point in time, there may be a period of time in the future where it is no longer true, and that is what makes these two theories so interesting.