What is Semi-Strong Form Efficiency?

//What is Semi-Strong Form Efficiency?
What is Semi-Strong Form Efficiency? 2017-10-10T06:34:35+00:00

Definition: The semi-strong form efficiency is a type of efficient market hypothesis (EMH), which holds that security prices adjust quickly to newly available information, thus eliminating the use of fundamental or technical analysis to achieving a higher return.

What Does Semi Strong Form Efficiency Mean?

What is the definition of semi-strong form efficiency? The SSFE does not use historical prices, trading volume, rates of returnearningsdividend payments, profitability ratios, stock splits or any other element of fundamental analysis. The hypothesis assumes that investors, who trade their securities based on newly available information, should expect an average risk rate of return. To outperform the market, investors should accept a higher level of risk.

Let’s look at an example.

Example

Agatha buys 500 shares of a construction company that currently trade at $38 per share. A few days later, she reads in the financial news that the company is expected to release outstanding results in the third quarter due to a successful deal with a foreign company.

Once the construction company releases its third quarter results, the stock price rises as expected. As a matter of fact, for a week, the stock price rises to $45 but then drops to $36. Agatha wonders why the price does not rise further.

Obviously, the market is semi-strong form efficient and adjusts quickly to the newly available information – in this case, the company’s strong results. To realize a profit, Agatha should sell some of her shares at $45 per share as soon as the market adjusted to the new information. Instead, Agatha held all her shares, thus losing money.

If Agatha had sold 200 shares at $45 per share, she would realize a gross gain of $9,000. Now that Agatha held all her 500 shares, she loses 500 x $45 – 500 x $36 = $22,500 – $18,000 = $4,500, i.e. the difference between the price she bought the shares and the price they trade.

Summary Definition

Define Semi-Strong Form Efficiency: Semi-strong form efficiency means an economic condition where the market adjusts prices of investments almost immediately as information is available.