Mean Reversion
The tendency of a series to return toward its long-run average after moving far away from it.
How it is identified
Test: extreme deviations from a long-run mean are followed on average by moves back toward that mean
Unit
qualitative
In depth
Mean reversion is well documented for volatility and for valuation multiples over long periods, and much weaker for prices themselves over short ones. Its central danger is that the mean can move: a business whose economics have permanently changed has a new normal, and waiting for reversion to the old one is how a value trap works. Strategies built on it tend to produce many small gains and occasional very large losses, since the position is added to as it moves against the trader. Whether a deviation is temporary or permanent is exactly the question the statistical property cannot answer.
Worked example
A stock's ten-year average P/E is 22 and it now trades at 13. Reversion would imply a 69% rise from the multiple alone — but only if earnings power is intact, which the multiple by itself does not establish.
Illustrative figures, chosen so the arithmetic is easy to follow. Not a live price and not a valuation of any company.
Educational reference only
This entry explains what “Mean Reversion” means. It is not investment advice and not a recommendation to buy or sell any security. Any numbers above are illustrative, not live prices, and nothing here predicts price direction or rates a stock. Consider your own circumstances and consult a SEBI-registered investment adviser before acting.