Understand mean reversion to help clients

Common wisdom says that, as an investor, you should avoid knee-jerk reactions to stock market fluctuations. And you’ve probably talked down your share of clients who had such reactions — perhaps even explaining mean reversion to them.

Support for mean reversion, along with further fine-tuning details, is provided in a report by Richardson GMP.

Using S&P 100 companies, the firm measured three-day share price changes — both up and down — over the last five years, as described in the report by Craig Basinger, CFA. Subsequent price moves were measured over three, five and 10 days.

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After analyzing the results, it’s clear that returns tend to be more substantial following a big price drop, and gains tend to be muted following a big price gain.

As a result, “Investors should not try and chase near-term returns after a sudden jump,” says Basinger. “And, following a sudden sell-off, may want to reconsider bailing, waiting for a potential short-term partial rebound.”

Read the full report.

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