DEFINITION of 'Overreaction'

A market hypothesis stating that investors and traders react disproportionately to new information about a given security. This will cause the security's price to change dramatically, so that the price will not fully reflect the security's true value immediately following the event. Typically, the price swing from overreaction is not long lasting, as the stock price will tend to return back to its true value over time.

The overreaction hypothesis is not consistent with the efficient market hypothesis.

BREAKING DOWN 'Overreaction'

For example, suppose that company XYZ releases its annual operating results, which beat analyst expectations by a mere penny per share (generally not a big deal). Traders and investors, however, subsequently bid up the stock to unprecedented highs. After a couple of days of trading, the stock then falls down to a price just above its price before the earnings release, which represents the stock's current intrinsic value.

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