A market is inefficient when asset prices do not fully or quickly reflect available information.
In such a market, securities may be mispriced. Some stocks may trade below their fair value, while others may trade above their fair value. Active investors try to identify these mispriced securities and earn profits.
However, these opportunities may not last for long. Once more investors notice the mispricing, they start trading, and the price moves closer to fair value.
Example:
Suppose a stock is trading at ₹400, but after analyzing its earnings, assets, and future growth, an investor estimates its fair value to be ₹500.
If the investor buys the stock at ₹400 and the price later rises to ₹500, the investor earns a gain of:
Gain = ₹500 – ₹400 = ₹100 per share
Percentage return = ₹100 / ₹400 × 100 = 25%
This opportunity exists because the market price did not immediately reflect the true value of the company.
But in a more efficient market, this price gap would close quickly.