What does mean reversion suggest about stock prices?

Mean reversion is a statistical concept that suggests that over time, the price of an asset will tend to move back towards its historical average or mean level. This means that if a stock price deviates significantly from its typical historical average—whether by increasing to a greater degree than normal or dropping significantly—it is likely to revert back to that average level over time.

This principle is based on the observation that, despite short-term fluctuations due to market sentiments or external factors, the long-term behavior of stock prices tends to stabilize around a certain average. Investors who recognize this phenomenon may seek to take advantage of these deviations, buying undervalued stocks that are below their historical average or selling overvalued stocks that have risen above it.

In contrast, the other choices do not accurately reflect the concept of mean reversion. Saying that prices are always increasing misrepresents the nature of market cycles; asserting that stock prices are unaffected by market movements overlooks the significant influence of economic and market conditions; and the notion that prices follow a random walk implies that past price movements have no bearing on future prices, which is counter to the concept of mean reversion. The correct understanding of mean reversion supports the idea that prices will eventually return to their historical average, which