It is assumed that the markets are efficient. In an efficient market when there are enough buyers assuming that the current price of a stock is low as compared to its intrinsic value, then the buyers buy the stock and move up the price.
There are three forms of efficient market hypothesis. They are mentioned below:
- Weak form of efficient market hypothesis – This form of efficiency says that current price of the stock ideally incorporates the necessary market information which is necessary to price the security. This means all information in the market is being reflected in the current stock price. This implies that the using of the past price trend and volume traded an investor cannot determine the future path of the stock. Lastly, this form of efficiency implies that an investor cannot earn excess returns with the help of the technical analysis (technical analysis is used to predict the future path of the stock using the historical information). Some of the market models like Capital Asset Pricing Model, APT require the markets to have at least weak form of efficiency.