When analyzing the price of lumber there is a key technical term to take into account. This is the term “Reversion to the Mean”
Mean reversion is a financial term for the assumption that a price will tend to move to the average price over time.
Knowing this term will help you understand which lumber items are over priced and under priced as compared to the mean and help you make buying decisions for your company. If a particular lumber item is over priced to the mean, you may want to only buy the item as needed vs. an item that is under priced to the mean, you may want buy more than you currently need.
Using mean reversion in lumber price analysis involves both identifying the trading range for lumber and computing the average price using analytical techniques taking into account considerations such as historical averages, correlations to other items, seasonal prices, etc.
When the current market price is less than the average price, the lumber is considered attractive for purchase, with the expectation that the price will rise. When the current market price is above the average price, the market price is expected to fall. In other words, deviations from the average price are expected to revert to the average. This knowledge serves as the cornerstone of multiple trading strategies.
Lumber reporting services commonly offer moving averages for periods such as 50 and 100 days. While reporting services provide the averages, identifying the high and low prices for the study period is still necessary.
Mean reversion has the appearance of a more scientific method of choosing lumber buy and sell points than charting, because precise numerical values are derived from historical data to identify the buy/sell values, rather than trying to interpret price movements using charts (charting, also known as technical analysis).
Mean reversion should demonstrate a form of symmetry since a Lumber may be above its historical average approximately as often as below.
A historical mean reversion model will not fully incorporate the actual behavior of lumber’s price. For example, new information may become available that permanently affects the long-term valuation.
To learn more about Sherwood Lumber’s Risk Management strategies click here. One Tool Sherwood Uses the help you protect price fluctuation is Forward Pricing