There are numerous types of trading and investing strategies on Wall Street. Many utilize statistics and probability theory to gain insight and make decisions.
Some are based on the concept of reversion to the mean. This is why The Goldman Sachs Group, Inc. GS is our Stock of the Day. There is a good chance that it reverses and heads lower.
The shares traded higher on Tuesday because Goldman blew away earnings estimates. The company stated that it earned $8.40 per share, which was well ahead of the Street's expectations of $6.85.
The company also reported revenue of $12.7 billion. This was well above the estimates of $11.8 billion. The Street likes these numbers.
But the stock is trading above its typical or average trading range. This means there is a good chance it will reverse back into the range, which would mean a move lower.
The red line on the chart is called a Bollinger Band. It is two standard deviations above the 20-day moving average.
Standard deviations are a statistical measurement.
According to statistics and probability theory, 95% of all trading should fall within two standard deviations of the mean or average. If a stock or market is outside of this range, it will attract the attention of trading strategies and algorithms based on these concepts.
A reversal may be imminent.
As you can see on the chart, Goldman’s shares are trading above the Bollinger Band. They have exceeded this important threshold to the upside, and the stock is overbought.
These dynamics could bring sellers into the market because they will be expecting a reversion to the mean or a move lower. Their selling may put pressure on the shares and force them down. It could become a self-fulfilling prophecy.
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