Skip to main content

Mean Reversion Strategy


There are many different types of trading strategies. Some traders trade with the trend buying high looking for higher highs or sell new low prices short looking for even lower lows in price, momentum strategies just look for a strong move to go a little farther, others trade a market inside a price range of support and resistance. What this article is going to talk about is the specific strategy of mean reversion, this is looking at prices as a kind of rubber band that stretches only so far and eventually snaps back to a historical long term average. 

Mean reversion trading strategies consist of signals that bet on extended prices eventually snapping back from overbought or oversold conditions and reverting back to the mean of historical pricing. It is a trade that takes a position on a quantifiable technical signal that price has moved too far and too fast in one direction and the probabilities that it will return to an average are high. 

One simple way to look for a reversion to the mean trade signal is by setting visual deviations around prices using technical indicators like Bollinger Bands or Keltner Channels that usually measure the distance from the 20-day moving in standard deviations of price. 

When a market drops dramatically or rises parabolically three or four deviations from the 20-day moving average the odds are that it will revert back to that average in days or weeks the majority of time. Of course this does not always happen as markets rotate from ranges to trends, and can go farther than anyone thought possible so you must always use a stop loss for the times when a trend continues and does not revert. 

One strategy is to buy dips to the lower 3rd standard deviation Keltner Channel or sell rallies short to the upper 3rd standard deviation Keltner Channel and set a stop loss if price closes back outside your entry channel signal. Your profit target could be back to the 20-day moving average. 

There is no magic or Holy Grail in reversion to the mean strategies and profitability comes from creating good risk/reward ratios, if it does not work out you should be stopped out for a small loss but if it reverts back to the mean then you should have a big win.  

A mean reversion entry is taking a trade that is at short term extreme prices that has a good chance of returning to more normal long term price metrics.

This Strategy can be used with 1:2 , 1:3 type of risk reward ratios and has a 70-80% winning ratio.

Share this Article with your Friends.


stockmarketadvisory.in

Comments

Post a Comment

Popular posts from this blog

Pre - Market Analysis (30th Jan 2022)

1. U.S Markets closed higher on Friday. 2. Right now , dow futures are lower. 3. Asian markets are mixed. 4. SGX Nifty is up 30-50 Points. 5. There's no point discussing Global markets today. 6. As we are dealing with our own local issues as of now. 7. The talk of the town is Adani Group. 8. Every stock Market participant during last 2 days have not spent as much time with their wife /gf /husband /bf as they have spent on researching Adani stocks. 9. They shouldn't have wasted so much time in research and should've spent their time with loved ones. 10. As Ultimately my Pre Market report would clear all. 11. Now , the Adani stock price has gone below the FPO price. 12. FPO price is in the range of 3100-3200 and stock price is around 2800  13. Who will subscribe to FPO when they can buy shares much cheaper from the Market? 14. Also over the weekend Adani has come up with a 450 page report addressing one by one the allegations made by Hindenberg.  15. I haven't
Post a Comment
Read more

Pre - Market Analysis (2nd Feb 2022)

1 U.S Markets closed lower Yesterday. 2. Right now , dow futures are lower. 3. Asian markets are mixed. 4. SGX Nifty is down 150 Points. 5. Yesterday was the Fed event in U.S 6. It was expected that they would raise rates by 25 basis points. 7. The same happened yesterday and in spite of that Markets crashed yesterday.  8. Yesterday was a highly Volatile day. 9. Markets were all over the place yesterday.  10. Before the budget , markets were higher. 11. During the budget , markets were flat. 12. After 1 pm markets were at the peak of Volatility.  13. Bank Nifty was down 1000 points by 2.45 pm. 14. In next 30 minutes it recovered all of its losses. 15. The budget was neither good nor bad. 16. The income tax slabs have been revised but also the insurance benefit has gone. 17. All the Insurance companies crashed yesterday.  18. This is a structural change coming out of budget now. 19. Adani stocks crashed yesterday.  20. So clearly there was valuation over hang which is gettin
1 comment
Read more

Nifty hits 17k (15th March 2023)

1. U.S Markets closed higher yesterday.  2. Right now , U.S Futures are lower. 3. SGX Nifty is up 80-100 points. 4. Asian markets are mixed. 5. There has been 4 days of relentless selling in our Markets  6. The reason doesn't seem to be Banking collapse in United States. 7. U.S Markets have settled after a knee- jerk reaction. 8. Our Markets haven't settled yet. 9. This isn't a selling like the previous ones. 10. Previously FII's used to target few nifty stocks  11. Used to sell them and create panic. 12. This selling is now an all around selling. 13. Broader Markets have been bleeding extensively. 14. There is pain all around. 15. Now 17300 becomes a very important resistance. 16. Nifty might retest 17300 and then break 17k. 17. Markets won't collapse in a hiff.  18. There would be intermittent rallies in between to take weak shorts out. 19. FII's have now been selling aggressively.  20. Nifty might trade between 17000 to 17300 today. 21. stockmarke
Post a Comment
Read more