But what is this powerful force, anyway?
http://mathworld.wolfram.com/ReversiontotheMean.htmlReversion to the mean, also called regression to the mean, is the statistical phenomenon stating that the greater the deviation of a random variate from its mean, the greater the probability that the next measured variate will deviate less far. In other words, an extreme event is likely to be followed by a less extreme event.
Although this phenomenon appears to violate the definition of independent events, it simply reflects the fact that the probability density function P(x) of any random variable x, by definition, is nonnegative over every interval and integrates to one over the interval (-infty,infty). Thus, as you move away from the mean, the proportion of the distribution that lies closer to the mean than you do increases continuously.
But is mean reversion a useful concept in finance? Jason Zweig says yes
“From financial history and from my own experience, I long ago concluded that regression to the mean is the most powerful law in financial physics: Periods of above-average performance are inevitably followed by below-average returns, and bad times inevitably set the stage for surprisingly good performance.”
But how can we harness this Power in our investments?
~ Ben CarlsonI can’t predict the future, but after the nice run up we’ve had for the past five years or so, it will probably make sense to look for markets that offer better value than the US markets do currently.
Unfortunately, Mr. Carlson said this in July, 2013 and since that time, the U.S. market advanced about 90% while emerging markets did 40%, while Europe the Pacific did about 50%. The good-looking markets didn't deliver -- Mr. Mean Reversion didn't show up.
What is the problem here? I'm guessing the problem is that Mean Reversion isn't anything more than a statistical abstraction, a chimera. We've been duped again. Phooey.