What Is It?
- Identifies price momentum and reversal tendencies.
- Projects the price of a stock one quarter ahead.
- Ranks stock’s level of attractiveness.
Price Projector statistically projects a stock’s price three months into the future based both on its momentum and on its potential for a reversal in its price towards a more normal level. The resulting percentage change from the actual current price to the projected price one quarter (three months) into the future is adjusted for the stock’s historical price variability. This variability-adjusted projected price change is used to rank the attractiveness of a stock in the Price Projector Model.
The underlying premise is that investors exhibit certain types of behavior that are reflected in patterns of stock prices.
Stock prices are a function of two forces:
- Momentum – the tendency of a stock to continue on a trajectory, and
- Reversal – the tendency of a stock to return to a price within a range that is “normal” for the stock.
Empirical analysis of stock prices provides evidence of persistence or momentum, in which stock prices that are rising tend to continue to rise and for stock prices that are falling to continue to fall.
While there is established evidence of momentum of price, both up and down, it is a general tendency or pattern with many exceptions. Momentum does not persist indefinitely but rather the general pattern tends to persist or trend for several quarters. Investors seem to only partially adjust their assessments of a holding in response to changes in important factors that influence price. This trending pattern of influential factors and investors’ partial adjustment to those factors often result in price persistence, either up or down.
Most investors can cite many examples where price has been driven to an unsustainable extreme that was followed by a reversal of the price to some average or normal level. This pattern is usually referred to as reversal-to-mean. This pattern exists because investors often exhibit a tendency to become overly optimistic or pessimistic about a stock’s prospects, driving its price to an extreme. When a more rational assessment of the holding and its prospects begins to prevail, the tendency is for the price to revert to a more sustainable normal level. This tendency of extreme price to revert to a more normal level is evident over relatively short time periods of approximately three to four months or less.
Even investors who integrate these two important price patterns into their investment approach tend to consider them independently or even as opposing patterns or forces. We strongly believe that momentum and reversal-to-mean are interacting forces that have significant influences on the behavior of prices.
Price Projector was explicitly designed to simultaneously quantify price momentum and potential for reversal-to-mean. It measures rates of change in the trend of a stock’s price to project that trend into the future. This is a way to capture and quantify momentum and price persistence. The model also measures the current price of a stock within a price channel that is determined by the historical variability of the stock’s price momentum. The likelihood and magnitude for reversal of a stock’s price toward some normal level becomes greater when the stock trades at an extreme position in relation either to the top or bottom of its price channel.
Note that our channel work is quite different from, and more sophisticated than, Bollinger Band analysis and similar methods of analysis.