Mean reversion

Mean reversion is the tendency for a number - say, the price of a house or a share - to return to its long-term average value after a period above or below it.

Mean reversion is the tendency for a number- say, the price of a house or a share- to return to its long-term average value after a period above or below it. For investors this presents an opportunity to buy or sell an asset confident that the price will eventually move up or down towards a long term average value.

For example, the average price earnings ratio for the FTSE 100 since it started is 14. At the height of the dotcom boom the index average shot up to 26, a clear 'sell' signal for many investors.

However, logical though this theory is, don't forget the maxim "the markets can remain irrational longer than you can remain solvent". In other words, even once you understand mean reversion, predicting when it will occur is not easy.

Most Popular

Ask for a pay rise – everyone else is
Inflation

Ask for a pay rise – everyone else is

As inflation bites and the labour market remains tight, many of the nation's employees are asking for a pay rise. Merryn Somerset Webb explains why yo…
17 Jan 2022
Temple Bar’s Ian Lance and Nick Purves: the essence of value investing
Investment strategy

Temple Bar’s Ian Lance and Nick Purves: the essence of value investing

Ian Lance and Nick Purves of the Temple Bar investment trust explain the essence of “value investing” – buying something for less than its intrinsic v…
14 Jan 2022
Interest rates might rise faster than expected – what does that mean for your money?
Global Economy

Interest rates might rise faster than expected – what does that mean for your money?

The idea that the US Federal Reserve could raise interest rates much earlier than anticipated has upset the markets. John Stepek explains why, and wha…
6 Jan 2022