4 thoughts on “February 16th, 2013”

  1. Aaron Howard says:

    If you look at stocks over time, there is always fluctuation in the price. Reversion to the mean is a concept used to try to answer the questions buy low. When is a stock’s value low? Some would suggest the value of a stock is low when it’s below the mean value. According to wikipedia, a mean reversion process can typically be used by those who sell stocks to make a stock or investment appear to be a better “value” than other analysis might indicate. As best I can understand mean reversion is a modeling process that operates within the range of stocks sale price and uses other factors like assets, earnings etc. to predict the average price. However rarely are these models complete enough for high confidence decision making.

  2. Aaron Howard says:

    I’ve been trying to figure this out off and on throughout the day. This term reversion to the mean seems to be a fairly broad concept in terms of tools that have been developed to identify opportunities in the market. Most of these tools such as Bollinger bands are broadly analysis of variance of a stochastic process. In a sense this is just more sophisticated statistic that with careful and experience application of theory could be used to aid in making investment evaluations. However, as with all statistical especially mystically complex ones whose basis is debated among experts the ability to misrepresent if not lie with data is as great or greater than this type of analysis is powerful.

  3. Mike Finley says:

    You were in the ballpark, Aaron. Let’s see how this concept can be understood and used by the average investor. What goes up, will come down. What goes down, will at some point go up. Let’s go back to our example of Gold from yesterday. The last decade has been very good for this commodity as its average yearly return since the year 2000 has been somewhere around 17% (before costs). What is its mean over long periods of time? Slightly above 4%. Hmmm…….

    Reversion to the mean tells us the speculation that has driven up the price of Gold will bring the prices back to earth (and probably with a hard landing) to its historical mean at some point in the future. This has happened recently with housing prices and even stock prices at the start of this century. So what is the point?

    Avoid chasing the hot investment that promises outsized returns for years to come. Gold is in a bubble and it will go pop soon, just like the tulip bubble, the multiple stock bubbles, the housing bubble, and the next bubble (you can replace Gold with Silver in this conversation as well). Do not get caught in bubbles. You will pay a very steep price as you chase past returns. What can you do?

    Buy no-load index mutual funds at minimal costs, diversify over stocks, bonds, and real estate and let others do the speculating. This simply means dollar cost averaging your money into the markets on a monthly and yearly basis without trying to time any particular market.

    Understanding reversion to the mean can help you avoid the worst investments and guide you toward the right investments. Financial education followed by action will serve you well. Beware of bubbles!

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