What is an Efficient Market?

Malcolm Tatum

Efficient markets are markets in which the flow of relevant information regarding investment options is easily accessed and reliable. In a market situation of this type, anyone who is involved in trading activity is able to make use of the information to assess the past performance of the security in question. The trader can also accurately identify the reasons for the current unit price and responsibly project the future performance of the security, based on current indicators.

In an efficient market, there are usually a large number of active traders functioning in the marketplace.
In an efficient market, there are usually a large number of active traders functioning in the marketplace.

In an efficient market, there are usually a large number of active traders functioning in the marketplace. A given trader may actively buy securities and sell other securities at the same time, based on the strength of the current unit price and projections on how the securities will perform in both the short term and the long term. Because the information regarding the securities in question is so well defined and so easily accessible, the trades take place with full confidence in how much return will be realized from each transaction.

One of the advantages of an efficient market is that there is no real incentive to initiate arbitrage transactions in order to build a strategy to make a decent return. The detail of existing information is such that it is relatively easy to minimize the difference between projected return and the degree of risk involved. Often, it is the current prices of the securities that are bought and sold that serve as the primary indicator, although other factors may help to strengthen the position of the pricing as an indicator.

When an efficient market exists, the quality of the information available is highly accurate. The details are analyzed thoroughly, broken down in a manner that both the investor and the broker can readily assimilate, and are being used by many investors to effect trades in the marketplace. While an efficient market does not completely remove the element of risk from any type of trading activity, trades made within a market of this type are generally considered to be less volatile in nature, assuming unforeseen factors do not significantly alter the general climate of the marketplace.

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As with any trading market, investors dealing in an efficient market are advised to assess all information in a timely manner. Doing so helps to further minimize the element of risk and increases the opportunity to make money from the trading activity.

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Discussion Comments


Low-risk investment equals low returns.

Although investors should avoid any deal that promises returns that are literally too good to be true, investors looking for a larger return should consider high yield bonds.

High yield, or junk bond, payments are more because the companies issuing the bonds have a greater risk of default.

In many cases, however, bondholders still get some return in the event of a default or even a bankruptcy filing, while shareholders rarely do.

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