How does competition among investors lead to efficient markets?

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How does competition among investors lead to efficient markets?




Answer: Competition between investors will tend to produce an EFFICIENT MARKET - that is, a market in which prices rapidly reflect new information, and investors have difficulty making consistently superior returns. Of course, we all hope to beat the market, but, if the market is efficient, all we can rationally expect is a return that is sufficient on average to compensate for the time value of money and for the risk we bear.
The efficient market theory comes in three flavors. the WEAK FORM states that prices reflect all the information contained in the past series of stock prices. In this case it is impossible to earn superior profits simply by looking for past patterns in stock prices. The SEMI-STRONG FORM of the theory states that prices reflect all published information, so that it is impossible to make consistently superior returns just by reading the newspaper, looking at the company's annual accounts, and so on. The STRONG FORM states that the stock prices effectively impound all available information.

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