What does the concept of mean reversion imply about a stock that has been performing well?

The concept of mean reversion suggests that asset prices, including stocks, tend to move towards their historical average or mean over time. When a stock has been performing particularly well, it is seen as being above its typical performance level. Mean reversion implies that a stock that has had a strong upward move might experience a decline in its price as it reverts to its historical average.

This principle is grounded in the idea that extreme price movements are often unsustainable and that factors driving the strong performance may not persist indefinitely. Thus, if a stock is trading significantly higher than its historical averages or trends, it might be an indicator to consider the possibility of an impending drop in price.

This understanding can guide traders and investors in their decision-making, leading them to consider selling or at least not buying into the stock at a higher price due to the likelihood of a pullback toward the mean.