What Are Historical Returns?
Historical returns are often associated with the past performance of a security or index. Analysts review historical return data when trying to predict future returns or to estimate how a security might react to a particular situation, such as a drop in consumer demand. Historical returns can also be useful when estimating where future points of data may fall in terms of standard deviations.
Historical Returns Explained
Looking at historical data can provide some insight into how a security or market has reacted to a variety of different variables, from regular economic cycles to sudden world events. Investors looking to interpret historical returns should keep one caveat in mind: you can't assume that the future will be like the past. The older the historical return data is, the more likely it is to be less useful when predicting future returns.
In contrast to traditional fundamental analysis methods, technical analysis is an analysis methodology used for forecasting the direction of prices through the study of past market data, primarily price and volume. Here, the historical returns are often analyzed for trends or patterns that may align with current financial and economic conditions. Technical analysts believe potential market outcomes may follow past patterns. Hence, there is hidden value available from the study of historical return trends.
In reality, results are mixed. As a dynamic and ever-evolving system, markets and economies at times repeat, but it is very difficult to anticipate when what's happened in the past will happen in the future. As such, you'd be hard-pressed to find financial literature that does not prominently feature the expression: past results are no indicator of future results. But euphoria and optimism prevail, and investors and their advisors erroneously put more weight on historical returns than they should.
When using historical returns, large-cap securities may exhibit more regular patterns than small cap securities. This is because large-cap securities have more liquidity than small-cap stocks.