[[Start here]] → [[expose to return drivers|drivers]] → [[strong stocks beat weak stocks|momentum]] → long term reversals --- My wife likes to tell me that everything comes back into fashion after a few years. This is equally true in the markets. A seminal study by DeBondt and Thaler (1985) illustrated an overreaction hypothesis - where the worst three to five year price losers have a tendency to bounce back, while stocks that have been the top winners for three to five years are at a high risk of reversal. There is a concept in maths known as '[[Mean Reversion]]' - that everything is magnetically drawn back to the average eventually. This is more true in the stock market than anywhere else. A chain of positive or negative results at a company leads to an expectation that the same results will continue. The market falls in love with it's 'darlings' while shunning the rejects. But corporate success breeds complacency and grows fierce competition, while failure breeds management resolve, determination and grit! As a result, high flyers often fall to earth while outcasts can rise like the phoenix. One perhaps might struggle to see these as 'momentum' effects', and indeed many see these reversals as a category of value investing (where [[cheap stocks beat expensive stocks|cheap beats expensive]]), but the fact that they can be analysed using price histories alone leads us we can catalogue them here! ## **Rules of thumb** - Prune your biggest winners after three to five years of outperformance -reversion risk rises sharply. - Hunt for future comeback stories among the long-term laggards - today’s rejects can be tomorrow’s stars. ## See also * [[value is best measured by a composite, not a single ratio]] - where we show the worst 5 year return losers outperformed high dividend yields! ## **Sources** - DeBondt, W. F. M., & Thaler, R. H. (1985). _Does the Stock Market Overreact?_ _Journal of Finance._ - Lakonishok, J., Shleifer, A., & Vishny, R.W. (1994). _Contrarian Investment, Extrapolation, and Risk._ _Journal of Finance._