Secret 8REGRESSION BACK TO THE MEAN
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“Regression back to the mean” is a statistical law that indicates
that when the results for some specific period or series of
events is extremely good or extremely bad, you can expect the results
to move closer to normal or the long term average.
For example, if a baseball team is really hot and wins a lot of
games in a row, it is likely to win fewer games in the future. In
pro football, the super bowl champion is likely to show poorer
performances in the next year, especially at the beginning of the
season, as it regresses back to the mean.
The same applies to the stock market. A hot fund manager is
likely to cool off next year. A wild bull market is likely to end up
in a bear market or major correction. When the stock market is
very quiet, it is likely to get much more volatility—the calm before
the storm. Options that are cheap and undervalued are likely
to become properly valued or expensive, and overvalued options
tend to get less expensive.
The regression back to the mean phenomenon is quite obvious
when investors pick mutual funds or investment advisors.
Generally, investors have very short vision. They only look at
present performance when much of that performance could be
luck rather than skill. Here you are likely to see regression back
to the mean. Today’s hot mutual funds are likely to underperform
in the future.
The law also applies to your behavior. If you are on a hot
streak, look out! You’re due for a losing streak as you regress to
the mean.
“Regression back to the mean” is one of the few tools that
you can use to forecast the future.
“Regression back to the mean” is a statistical law that indicates
that when the results for some specific period or series of
events is extremely good or extremely bad, you can expect the results
to move closer to normal or the long term average.
For example, if a baseball team is really hot and wins a lot of
games in a row, it is likely to win fewer games in the future. In
pro football, the super bowl champion is likely to show poorer
performances in the next year, especially at the beginning of the
season, as it regresses back to the mean.
The same applies to the stock market. A hot fund manager is
likely to cool off next year. A wild bull market is likely to end up
in a bear market or major correction. When the stock market is
very quiet, it is likely to get much more volatility—the calm before
the storm. Options that are cheap and undervalued are likely
to become properly valued or expensive, and overvalued options
tend to get less expensive.
The regression back to the mean phenomenon is quite obvious
when investors pick mutual funds or investment advisors.
Generally, investors have very short vision. They only look at
present performance when much of that performance could be
luck rather than skill. Here you are likely to see regression back
to the mean. Today’s hot mutual funds are likely to underperform
in the future.
The law also applies to your behavior. If you are on a hot
streak, look out! You’re due for a losing streak as you regress to
the mean.
“Regression back to the mean” is one of the few tools that
you can use to forecast the future.