Strong-Form Efficiency

Written By
Paul Tracy
Updated November 4, 2020

What is Strong-Form Efficiency?

Strong-form efficiency is a component of the random walk theory and states that market and securities prices are not random and are influenced by past events. Strong-form efficiency is the opposite of weak form efficiency.

Princeton economics professor Burton G. Malkiel coined the term in his 1973 book A Random Walk Down Wall Street.

How Does Strong-Form Efficiency Work?

There are two forms of the random walk theory. In both forms, the rapid incorporation of information is disadvantageous for investors and analysts. The semi-strong form states that public information will not help an investor or analyst select undervalued securities because the market has already incorporated the information into the stock price. The strong form states that no information, public or inside, will benefit an investor or analyst because even inside information is reflected in the current stock price.

Why Does Strong-Form Efficiency Matter?

The strong form of the random walk theory essentially proclaims that it is impossible to consistently outperform the market, particularly in the short term, because it is impossible to predict stock prices. This may be controversial, but by far the most controversial aspect of the theory is its claim that analysts and professional advisors add little or no value to portfolios, especially mutual fund managers (with the notable exception of those managing funds that take on greater risks), and that professionally managed portfolios do not consistently outperform randomly selected portfolios with equivalent risk characteristics. As Malkiel put it, "Investment advisory services, earnings predictions, and complicated chart patterns are useless....Taken to its logical extreme, it means that a blindfolded monkey throwing darts at a newspaper's financial pages could select a portfolio that would do just as well as one carefully selected by the experts."

Malkiel therefore advocates a buy-and-hold investing strategy as the best way to maximize returns; he also advises investors to obtain life insurance, understand their risk tolerance, make tax-advantaged investments, ensure their short-term investments keep pace with inflation, consider bond investments, buy instead of rent, consider investing in gold and collectibles, use a discount broker, and diversify.

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