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Investment Approach:
Price Projector Model
Channel Trend’s Price Projector Model is a price behavior model. Price Projector is our most important and best performing model. The premise underlying this model is that investors exhibit certain types of behavior that are reflected in patterns of stock prices. Many investors and investment academicians believe that stock prices move randomly and cannot be predicted. We disagree.
Two of the more important and powerful stock price patterns are persistence, often referred to as momentum, and reversal-to-mean, or the tendency of extreme stock price levels to revert to some average or normal level. 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 evidence of momentum of stock prices, both up and down, it is a general tendency or pattern with many exceptions. Also, momentum does not persist indefinitely, with evidence that this general pattern persists for about six months to a year.
Why is there evidence of persistence and momentum of stock prices? Some researchers feel that factors that impact a stock’s price, such as a company’s earnings, do not move randomly, but also have some tendency to move in persistent trends. Investors seem to only partially adjust their assessments of a stock in response to changes in important factors that influence its price. This trending pattern of influential factors and investors’ partial adjustment to those factors often results in persistence and momentum, either up or down, in a stock’s price.
While persistence and momentum of stock prices are thought to reflect a tendency of investors to only partially adjust to a company’s changing conditions, most investors can also cite many examples where a stock’s 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 seems to exist 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 stock and its prospects begins to prevail, the tendency is for the stock’s price to revert towards a more sustainable normal level. This tendency of extreme stock prices to revert to a more normal level is evident over relatively short time periods of about three months or even less and over longer time periods of one year and even longer.
Even investors who integrate these two important stock price patterns into their investment approach tend to consider them independently or even as opposing patterns or forces. However we see momentum and reversal as two important interacting factors or patterns that influence stock prices. In fact, Channel Trend believes that momentum and reversal are important interacting forces that have significant influences on the behavior of stock prices.
Channel Trend’s Price Projector Model was explicitly designed to simultaneously quantify a stock’s price momentum and its potential for reversal-to-mean. The model 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 a stock’s momentum or price persistence. The model also measures a stock’s current price within a price channel that is determined by the historical variability of the stock’s price. The model then estimates the position within the price channel at which the stock is most likely to trade in the future, given 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.
The Price Projector Model statistically projects a stock’s price three months into the future based both on its price momentum and on its potential for a reversal in its price towards a more normal level. The resulting percentage change from a stock’s actual current price to its projected price three months into the future is adjusted for the stock’s historical price variability. This variability-adjusted projected percentage price change is used to rank the attractiveness in the Price Projector Model. See Historical Performance of this model.
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