Mean Reversion
Mean reversion is the assumption that prices oscillate around a long-term mean. When price moves significantly above or below that mean, mean-reversion strategies enter expecting a return. Common implementations include RSI buy-the-oversold, Bollinger Band reversion, and pairs trading.
When mean reversion works
Range-bound forex pairs in quiet sessions are the natural habitat. EUR/USD in mid-summer, USD/CHF most of the time, AUD/JPY between central bank meetings.
When it fails
Strong trends destroy mean reversion. Bitcoin in a parabolic move, gold during a flight-to-safety rally, indices in a Fed pivot. The asset can stay "overbought" for months.
Filters that help
- ADX < 25 — only trade in non-trending conditions
- Bollinger Band width contracting — only trade in low-volatility ranges
- Time-of-day filters — many pairs mean-revert in Asian session, trend in NY session
Strategies that use Mean Reversion
Related Terms
Trend Following
Trend following is the strategy of buying assets that are going up and selling assets that are going down — counterintuitively, the most-profitable systematic style for retail traders.
RSI (Relative Strength Index)
The RSI oscillates between 0 and 100, measuring the velocity of recent gains vs losses to identify overbought and oversold conditions.
Bollinger Bands
Bollinger Bands plot two standard deviations above and below a moving average, defining a dynamic range for price.
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