Mean reversion strategy

Mean reversion strategies assume that a stock's price will tend to move to the average over time.  Mean reversion strategies work well when momentum strategies aren't working so both these types of strategies are useful to have in your suite of trading strategies ready to employ depending on market conditions. Mean reversion traders seek out extreme events and then enter to take advantage of a move back to nearer the average.

Mean reversion strategies can include:

• using indicators to indicate overbought or oversold price action
• strict rules on entry, exits and risk management

Trades are generally taken from daily (or smaller timeframe) charts. The following is an example of a mean reversion trade:

(chart coming soon)

Mean reversion strategies might suit people who:

• have trading software enabling the to backtest their strategies
• are able to make quick decisions and act on those decisions

Let's take a closer look at a possible mean reversion strategy and how to develop a trading plan to capture these trades.