In investing, there are many situations in which it makes sense to look at how two different numbers relate to each other over time. Whether you're talking about two stocks in the same industry, the prices of two related commodities, or any other pair of numbers, calculating the average percentage difference over time can give you a benchmark against which to compare their recent behavior.
Below, we'll go through the basics of calculating average percentage differences and provide some insight into how to interpret the results.
Calculating the average percentage difference
To calculate the average percentage difference over time, you'll need to build a time series of data. The starting point is the price information for each date on which you're producing an average.
First, calculate the difference between the two prices for each date. You'll need to pick one set of numbers to be the starting point on which the percentage difference will be calculated, and then subtract the other number from it. It's important to be consistent throughout the time series by subtracting the correct number from the other. It's possible that some differences will be positive while others will be negative.
Next, calculate the percentage difference for each date. To do so, divide the difference figure by that date's number from the set you chose as the starting point for the calculation. Again, these percentages can be positive or negative.
Finally, add up all of the percentage differences for the dates and divide by the number of dates you examined. The result is the average percentage difference for the series.
How to use the average percentage difference
The meaning of the average percentage difference depends on the nature of the two numbers involved in the calculation. For instance, if you're looking at a comparison between prices of Brent crude oil on the global market and prices of West Texas Intermediate crude on the U.S. market, the average percentage difference reveals how the two markets interact.
More generally, though, the average percentage difference is a useful indicator for examining future trends. If you know that the average percentage difference over long periods of time tends to stay constant, then future departures from that average can indicate temporary periods of irrational behavior. That can create investing opportunities for contrarians willing to wait for a reversion to the mean.
The math behind average percentage differences isn't complicated, but how you use the information can be. Over time, you can build expertise to help you interpret exactly what a given average percentage difference will mean in the markets you're analyzing.
