Final answer:
The Efficient Market Hypothesis posits that stocks always trade at their fair value because all available information is already reflected in stock prices, thus making it impossible to consistently outperform the market through analysis or predictions. Stock prices respond to new information by following a 'random walk with a trend', indicating that day-to-day movements are unpredictable but the general trend over time is upward. Consequently, discovering a stock that will outperform is considered largely a matter of luck.
Step-by-step explanation:
Understanding the Efficient Market Hypothesis
The Efficient Market Hypothesis (EMH) suggests that stock prices fully reflect all available information and therefore are indicative of the true value of the respective stocks. According to the EMH, stocks always trade at their fair value, making it impossible for investors to purchase undervalued stocks or sell stocks for inflated prices. It thus contends that it is not possible to outperform the market through traditional fundamental analysis or technical analysis over the long term.
EMH proposes that any new information relevant to a company's value is quickly and accurately incorporated into stock prices, with stock prices adjusting almost instantaneously. This efficiency arises from the continuous action of investors and analysts, who are assessing and acting on new information 24 hours a day. Because of this, the theory suggests that the market follows a "random walk with a trend" pattern, meaning that day-to-day fluctuations are unpredictable ('random walk'), but stocks tend to increase in value over time ('with a trend').
Those who subscribe to the EMH therefore believe that finding a stock that will perform better than the market expectations is largely a matter of chance rather than skill, since all relevant information is already reflected in the price of the stock.