No. of Recommendations: 3
The theory behind this is that market inefficiencies are noticed, taken advantage of by enough people that the the inefficiencies disapear. In essence enough people join to force reversion to the mean. The method becomes the average maker or at least one of the average makers.

Is the cause and affect assumed here justified? Do other factors explain a reversion to the mean?(assuming reversion to the mean isn't a myth lol). Do market cycles play a greater roll then numbers of method adherents? Do macro economics play a greater roll then numbers of method adherents?

I would say that all of the above play a part, as well as some other factors.

Macro economics has the most influence when there's a major shift in paradigm - a la China/India developing capabilities and capitalizing on them. (This tends to wreak havoc with indices.)

Certainly cycles play a part. The casual investor notes the trend and tries to follow it - usually late in the game.

Liquidity plays another part. If there's a lot of money chasing gains there will be some number of people who pile in at the end to hold the bag - cutting liquidity. This leads to...

Economic behaviorists observe that people are great at spotting trends - even if they don't exist or if they haven't taken into account all the factors. Trends change before people spot them and some number of folks don't see it. Consider:

A number of people gravitate to whatever is "hot". (In the late 90's, it was stocks. After the downturn in 2000-2001, it was small caps. Then there was bonds, REITs, condos, hedge funds...)

And there's also "investor psychology". (One of the guys I work with mortgaged his house to buy Microsoft - just before the judge ruled against them and watched his investment shrivel.)

And lack of due diligence - MDH noticed (many years ago) that his bond fund grew when the stock market tanked. We borrowed money for home improvements about 9-10 years ago, but didn't need it immediately. He put it in bonds, expecting another increase but neglected to realize market circumstances were different. (He doesn't trust bonds to this day.)

I'm sure others can add to this discussion...


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