When you get your MBA (you probably shouldn't, unless its free, but that's another post), one beloved pastime of business professors is to sermonize the Efficient Market Hypothesis.

The hypothesis goes like this: if a reliable valuation model predicted that in, say, the next three days a company's share price would go from $100 to $110, you and every other investor would place an order to buy, while no current shareholder of the company would be willing to sell. The net effect would be an immediate jump in the stock price to $110.

The forecast of a future price increase will lead instead to an immediate price increase. In other words, the stock price will immediately reflect the "good news" implicit in the model's forecast.

In general, any information that could be used to predict stock performance should already be reflected in stock prices. As soon as there is any information indicating that a stock is underpriced and therefore offers a profit opportunity, investors flock to buy the stock and immediately bid up its price to a fair level.

If prices are bid immediately to fair levels, given all available information, it must be that they increase or decrease only in response to new information. New information, by definition, must be unpredictable; if it could be predicted, then the prediction would be part of today's information. Thus stock prices that change in response to new (unpredictable) information also must move unpredictably.

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Stock prices should follow a "random walk" that is, the price change should be random and unpredictable. Randomly evolving stock prices would be the necessary consequence of intelligent investors competing to discover relevant information on which to buy or sell stocks before the rest of the market becomes aware of that information.

Don't confuse randomness in price changes with irrationality in the level of prices. If prices are determined rationally, then only new information will cause them to change. Therefore, a random walk would be the natural result of prices that always reflect all current knowledge. Indeed, if stock price movements were predictable, that would be damning evidence of stock market inefficiency, because the ability to predict prices would indicate that all available information was not already reflected in stock prices.

Therefore, the notion that stocks already reflect all available information is referred to as the efficient market hypothesis.